What Are the Risks of Forex Trading for Beginners?

The forex market helps facilitate the buying and selling of various global currencies. Its end goal is to allow the forex trader to yield a net profit by buying currency pairs at a lower price and selling them at a higher one. This is one similarity it shares with stocks.

If you’re a trader using a forex funded account, you have the advantage of choosing between a handful of currencies. Stock traders don’t have this option, as they must analyze thousands of listed companies and sectors. 

When it comes to the trading volume, the forex markets are by far the largest. Additionally, they’re classified as liquid assets because of their high trading volume. Most of these advanced trading transactions consist of currency swaps, spot transactions, options, and forwards.

While trading using true forex funds has its benefits, it also has its risks. But first, what is SDR?

What Is SDR

The Special Drawing Rights (SDR) refers to an international reserve asset started by the International Monetary Fund in 1969. Its purpose is to help supplement the national reserves of its member countries. 

It’s worth noting that the SDR is in no way a currency on its own. Instead, it’s a probable claim on the freely usable currencies of its member countries. In this case, it can assist in providing IMF member countries with liquidity whenever the need arises. 

Several currencies help define it. These are the US dollar, Chinese Yuan, Euro, the British Pound, and the Japanese Yen. Since its inception, the fund has allocated a total of US$943 billion. The latest allocation was done on August 23, 2021. 

Six Risks of Forex Trading for Beginners

As lucrative as forex trading is, it does have certain risks. They include the following. 

1. Leverage Risks

In advanced trading, leverage requires that a trader makes a small initial investment, referred to as a margin. This investment enables them to gain access to significant trades in global currencies. If a price fluctuation happens, this leads to something called a margin call. 

Whenever a margin call happens, the trader is expected to pay an extra margin. When faced with volatile market conditions, aggressively using your leverage can lead to substantial losses. These are losses that are likely to surpass your initial investment. 

2. Transaction Risk

The transaction risk refers to a risk related to the time difference between contract initiation and subsequent settlement. It’s among the primary risk factors beginner traders will face when using a forex funded account. This risk is contingent on the prevailing exchange rates.

Given that forex trading happens at all hours, the exchange rates are bound to change before a given trade has settled. This means you need to be prepared to trade currencies at varied rates throughout the day. 

Remember, the longer the time lapse between initiating a trade and settling it, the higher your risk will become. As the exchange rates continue to fluctuate, a trader may find themselves faced with excessive transaction costs on their trades.

3. Interest Rate Risks

The one thing that all basic macroeconomic courses teach is that interest rates can adversely affect a given country’s exchange rates. For example, if the interest rates were to rise, this means that its currency would strengthen. 

A strong currency helps bring in more foreign investment. This, in turn, leads to higher returns for the investors. On the other hand, if the interest rates begin to fall, the currency will become affected, causing investors to pull back on their investments. 

Considering the nature of the interest rates and their winding effect on exchange rates, the differences between different currency values can affect the forex prices. It can cause them to change dramatically, regardless of whether the rates are rising or falling. 

4. Country Risk

When looking at the forex funds options to invest in, a trader will need to assess the stability and structure of the issuing country. For example, in most developing countries, their exchange rates are fixed to that of a world leader, e.g., the US dollar. 

In such a case, the country’s central bank will need to sustain certain reserves to maintain a fixed exchange rate. However, you should note that a currency crisis can occur if the country is experiencing an ongoing balance of payment deficits. 

Such deficits will lead to the devaluation of its currency. Devaluation will, in turn, cause a ripple effect on forex trading and currency prices. 

Looking at the speculative nature of advanced trading, a trader may start to withdraw their assets if they suspect that a currency will lose its value. The withdrawal of these assets will result in the further devaluation of the said currency. 

Traders who will continue trading on the affected currency will find that their assets have become illiquid. A good example of this is what happened during the Argentine Crisis and the Asian Financial Crisis. 

5. Counterparty Risk

In a financial transaction, the counterparty refers to the company that has provided the investor with the asset they’re using to trade. A counterparty risk can, therefore, be described as the risk of default from a broker or dealer in a given transaction. 

When you look at forward contracts, spot, and forex trades, the currencies used to trade aren’t guaranteed by a clearing house or exchange. In a spot currency trading transaction, a counterparty risk will arise from the solvency of the market maker. 

This means if the market becomes volatile, the counterparty may refuse to fulfill its contracts. 

6. Social Risk

Social risk has a direct correlation to the social issues happening in a country. It can include the potential for political and social instability, as well as social and economic issues. You can mitigate social risk by working with a broker whose reputation you can trust. 

Risk Management Strategies for Trading with a Forex Funded Account

Now that you know the risks you’re likely to face as a beginner trader, you should also learn the strategies you can employ to mitigate them. These strategies tend to vary from one trader to the next, but their goal is the same – to reduce the impacts of risk. They include:

• Using Stop Loss Orders: They help you avoid big losses that may arise when a certain trade goes against you. You can implement this strategy for both short and long trades. Make sure to set your stop loss in a manner that allows it to work for your trading preferences. 
• Quick Identification of Your Trades: Ensuring you identify your trades early allows you to look at your risk more keenly to ensure you’ll get the most out of it. Quick identification leads to a proper evaluation informed by proper planning. 
• Use Margin for Your Long Positions: Whenever you take long positions, be sure to implement a strategy that makes it easier to manage your risks. Most advanced trading platforms have this feature. Use it to help you get the most out of your initial investment.

Conclusion

Looking at the five types of risks mentioned above, beginner traders need to understand that the losses they incur may, at times, be bigger than initially expected. Additionally, owing to the nature of leveraged trades, their margins can lead to significant losses. Other factors that can contribute to illiquid assets include political issues and time differences that have far-reaching complications on the country’s currencies. Traders need to remember that while forex assets have a high trade volume, their risks are apparent and may lead to substantial losses.